This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning the link between The Coca-Cola Company (NYSE:KO)’s return fundamentals and stock market performance.
If you purchase a KO share you are effectively becoming a partner with many other shareholders. Owing to this, it is important that the underlying business is producing a sufficient amount of income from the capital invested by stockholders. You need to pay attention to this because your return on investment is linked to dividends and internal investments to improve the business, which can only occur if the company is expected to produce adequate earnings with the capital that has been provided. To understand Coca-Cola’s capital returns we will look at a useful metric called return on capital employed. This will tell us if the company is growing your capital and placing you in good stead to sell your shares at a profit.
What is Return on Capital Employed (ROCE)?
You only have a finite amount of capital to invest, so there are only so many companies that you can add to your portfolio. Therefore all else aside, your investment in a certain company represents a vote of confidence that the money used to buy the stock will grow larger than if invested elsewhere. So the business’ ability to grow the size of your capital is very important and can be assessed by comparing the return on capital you can get on your investment with a hurdle rate that depends on the other return possibilities you can identify. To determine Coca-Cola’s capital return we will use ROCE, which tells us how much the company makes from the capital employed in their operations (for things like machinery, wages etc). I have calculated Coca-Cola’s ROCE for you below:
ROCE Calculation for KO
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = US$11b ÷ (US$87b – US$31b) = 18%
KO’s 18% ROCE means that for every $100 you invest, the company creates $18.2. This shows Coca-Cola provides a favourable return to capital holders, which beats the 15% ROCE that is typically considered to be a strong benchmark. As a result, if KO is clever with their reinvestments or dividend payments, investors can grow their capital at an attractive rate over time.
A deeper look
The encouraging ROCE is good news for Coca-Cola investors if the company is able to maintain strong earnings and control their capital needs. But if this doesn’t occur, KO’s ROCE may deteriorate, in which case your money is better invested elsewhere. Because of this, it is important to look beyond the final value of KO’s ROCE and understand what is happening to the individual components. Looking three years in the past, it is evident that KO’s ROCE has risen from 17%, indicating the company’s capital returns have stengthened. In this time, earnings have actually fallen from US$12b to US$11b, but the use of capital has fallen further due to a decreased level of total assets employed , which suggests investor’s ROCE has risen because the company requires less capital to create earnings despite the previous decline in EBT.
Coca-Cola’s ROCE has increased in the recent past and is currently at a level that makes the company an attractive candidate that is capable of producing solid capital returns, and hence, an attractive return on investment. This makes the company an attractive place to put your money, but ROCE does not tell the whole picture so you need to pay attention to other fundamentals like future prospects and valuation. It’s important to account for these factors because you cannot be sure if this trend will continue or if you are getting a good deal for the future returns you are paying for. If you’re interested in diving deeper, take a look at what I’ve linked below for further information on these fundamentals and other potential investment opportunities.
- Future Outlook: What are well-informed industry analysts predicting for KO’s future growth? Take a look at our free research report of analyst consensus for KO’s outlook.
- Valuation: What is KO worth today? Is the stock undervalued, even if its ROCE is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether KO is currently mispriced by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.